Explained: Investing In Mutual Funds To Meet Short Term Goals

Mutual funds invest in a broad range of asset classes, including but not limited to fixed income securities, cash, bonds, and equities. That means they can be used to address several goals for the short, medium and long term.

That means investing in mutual funds can also help you meet your short-term such as buying that phone you've been eyeing, planning for your vacation six months down the line, saving up for 6 to 9 months' worth of living expenses and more.

So why don't more people do it? One reason is that many wrongly assume that mutual funds are only for the long term. And that has led to several investors missing out on valuable opportunities to meet their short-term goals.

BOOM busts the myth that mutual funds cannot be used for short term investing.

1. What instruments do mutual funds invest in for short-term returns?

Short-term mutual fund schemes invest in securities for a few days to a few weeks and even a few years. For instance, liquid funds are low duration mutual funds with a portfolio maturity of fewer than 91 days.

Then there are ultra-short-term bond funds, which are low duration mutual funds with a portfolio maturity of fewer than 12 months. You also have short-term bond funds that are regarded as medium duration mutual funds with an underlying maturity ranging from one year to three years.

While most equity schemes help meet long-term goals, debt mutual funds are ideal if you're looking to meet a short-term goal that is less than five years away.

2. What Are Short Term Goals?

Goals that fall within the ambit of five years are regarded as a short-term goals

Examples of such goals include an international vacation, or doing something big in the next five years.

It could also include a down payment on a house, buying a new car, planning your wedding or higher education. The list is endless.

3. How To Meet Your Short Term Goals With Mutual Funds

When it comes to saving for your short-term goals, time matters. So that means, if you need money soon, you cannot afford to invest it in the stock market.

In the mutual fund arena, there are three kinds of debt funds suited explicitly for short-term investments. They are:

1. Liquid Funds. These funds invest in debt instruments that have a maturity of up to 91 days. You can expect low volatility and consistent returns from liquid funds. These funds work best if you're looking to park your money for a few days.
2. Ultra Short Duration Funds. These funds are similar to liquid funds as they are also open-ended debt funds. They invest in fixed income securities, but the maturity ranges from three months to six months. If your goal is less than six months away, short duration funds can be a suitable alternative for the timeframe.
3. Money Market Funds. These funds invest in money market securities with a maturity of up to 12 months. Since their maturity is longer than liquid and short-duration funds, money market funds could be more sensitive to changes in market interest rates.

4. Risks associated with short term funds

Short-term funds invest in securities with a short-term maturity period ranging between a few days, a few months, to a few years. That means you are assured of high liquidity.

Also, in comparison to equity funds, short-term funds are relatively safe. But like every investment, there is no complete safety. One of the most significant risks of short-term funds is interest rate risk -- it means your investment could decline if there is a change in the interest rate. This specific risk applies to short-term funds because of the limited maturity time.

5. How To Start Investing For Your Short Term Goals?

1. Identify your financial goals. Quantify your objectives and set a time horizon with an approximate cost. When listing and quantifying your goals, ensure that you take inflation into account, especially for purposes that may have more than a one-year time horizon.
2. Look at where you want to save or invest. Let's say you have a short-term goal of accumulating ₹3 lakh in two years. You can choose to invest in short-term debt funds or invest a lump sum of ₹1 lakh in a debt fund. In addition to the lump sum, you can begin a SIP of ₹7500 every month for two years in a debt fund to achieve your target. Assuming the rate of return from debt funds is 5.5% per annum, you could meet your goal of ₹3 lakhs in two years. While this was just an example, identify the right mutual fund investments for your short-term goals depending on the time horizon.
3. If your time horizon is fewer than five years but more than two years, you could focus on ultra-short-term funds or short-term gilt funds or even short to medium-term debt funds.

This story is part of the BOOM Money explainer series on personal finance